How secured business loans work
A secured business loan works by backing the loan with collateral. Collateral can be a piece of property, equipment or any other type of business asset. If your business defaults on the loan, your lender will seize the collateral to cover the outstanding principal and interest.
Secured business loans are one of the most common types of business financing. That’s because lenders see a secured loan as less risky than an unsecured loan — they ensure repayment, even if the business fails. You can find this type of financing through most lenders, including banks, credit unions and online financial technology (fintech) lenders.
Less risk for the lender typically means a better deal for you. A secured loan often comes with lower rates and fees than an unsecured loan. Backing your loan with collateral can also help your business receive a large loan amount or qualify with less-than-stellar credit.
What can I use as collateral?
Collateral you may be able to use on a secured business loan include:
- Business inventory
- Business equipment
- Business equity
- Commercial vehicles
- Unpaid invoices
In some cases, a lender will place a blanket lien on business assets, rather than requiring you to back it with specific collateral. This allows the lender to seize any asset if a business defaults on a loan. Blanket liens are especially common with fintech lenders.
You can also use personal assets like your home, vehicle or stocks as collateral. But your state may have restrictions on the type of assets you can use — especially when it comes to assets with fluctuating value, like home equity.
If you don’t have any assets at all, you might need to consider an unsecured business loan. Unsecured business loans don’t require a specific asset, but tend to have stricter eligibility criteria and may still require a personal guarantee.
How much collateral is needed for a business loan?
Are personal guarantees the same thing as collateral?
A personal guarantee is similar to collateral, but they’re not the same thing. A personal guarantee is when business owners agree to pay off the loan if the business is unable to meet the debt obligation.
It sounds similar to collateral, but the key thing to remember is that personal guarantees mean the business owners can repay the debts however they wish. With collateral, the asset is what’s used to repay debt.
5 types of secured financing
How to qualify for a secured business loan
To qualify for a secured business loan, businesses typically need to meet the following requirements — at a minimum:
- At least 12 months in business. The longer you’ve been in business and earning a profit, the better your odds. Most business providers require at least 12 months in operation — or up to two years in some cases — to qualify for business loans.
- Good personal credit. You’ll have the most options if you and all other majority owners have a personal credit score of 670 or higher.
- Valuable business assets. Typically you’ll need assets that are valued at around 100% to 125% of the amount you want to borrow. Ideally, the value will remain the same over time.
- Eligible industry. Some lenders won’t accept businesses in high-risk industries, such as construction, cannabis or gambling.
Dive deeper Business loan requirements. What lenders look for in a firm
Pros and cons of secured business loans
Secured loans may have higher acceptance rates and lower APRs than an unsecured loan. But they’re not without their downsides.
Pros
- Lower rates. Secured loans tend to come with lower interest rates and origination fees than unsecured loans.
- Larger loan amounts. Since there’s less risk to the lender, you may be able to get a larger loan amount.
- Easier to qualify for. Because the collateral protects the lender from default, secured loans can be easier to get.
- May be less risky for you. If you go with a secured loan and choose your collateral, you may be able avoid blanket liens or personal guarantees.
Cons
- Time-consuming. Your assets for a secured loan must be appraised, which can be a time-consuming process.
- Additional fees. Appraisal fee, origination fees and application fees may be something to plan for with a secured loan.
- Lose your asset(s) if you default. Defaulting on the loan could have serious consequences for the future of your business, especially if you used property or personal assets as collateral.
5 alternatives to secured business loans
A secured loan can be great for a business looking to expand or get some new equipment. But it comes with significant risk — if things go south, the collateral is on the chopping block.
If a secured loan isn’t what you’re looking for, here are some alternatives to consider:
- Unsecured business loans — If you don’t have any assets you want to use to secure a loan, then going the unsecured route may still work for you. However, remember that even lenders that advertise themselves as “unsecured” may still require a personal guarantee from the majority owners.
- Personal loans — While typically more expensive than secured business loans, personal loans can be used for pretty much anything. And many personal loan providers require significantly less documentation for the application than your run-of-mill business lender.
- Invoice financing and factoring — A type of advance on your unpaid accounts receivables, invoice financing and factoring can help businesses in tough spots or during slow periods. But be aware that they can be costly.
- Microloans — Only looking for a small loan? Microloans can be a good option for startups or businesses that only need a small sum. Some providers help fund microloans with crowdfunding, such as Kiva.
- Merchant cash advances — As the name suggests, a merchant cash advance is an advance that’s based on your card sales. However, it can be a precarious and expensive type of financing, so it may be best suited for emergency situations.